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What is A Dual-Class Stock Structure and Do I Want It?

Emerging Companies Practice Briefs

 

What is a Dual-Class Stock Structure?

A dual-class stock structure basically means that a company has given disproportionate voting rights to one group of shareholders, typically its founders. In most companies, one share of stock equals one vote. But companies with dual-class structures give founders super-voting stock that may have 10 or more votes per share, though it’s treated the same as other common stock in terms of economic rights.

Dual-class structures are becoming more popular because a number of highly visible companies have implemented super-voting stock. Companies with visionary founders, like Facebook, Snap[1] and Alphabet, have put such structures in place as a means of preserving founder control.  As an example, Facebook has Class A shares and Class B shares. Investors hold Class A shares, but Mark Zuckerberg holds Class B shares, which have 10 votes each. His shares represent roughly 14% of Facebook’s economic ownership but control nearly 60% of the voting rights.  

A Look at the Math

Let’s take a quick look at how super-voting shares work in practice, in a company with two co-founders, a couple of key employees and other stockholders. Here, the founders only own 30% of the company, but control 81% of the vote:

 

Shares

% Ownership

Votes

Voting Power

Founder 1

100 Class A

10%

1,000

27%

Founder 2

200 Class A

20%

2,000

54%

Key Employee 1

50 Class B

5%

50

1.4%

Key Employee 2

50 Class B

5%

50

1.4%

Others

600 Class B

60%

600

16.2%

 

1,000 Shares

100%

3,700

100%


Why Put in Place a Dual-Class Structure?

Whether a dual-class structure makes sense for a company is highly situation-specific. Founders that want to protect their vision[2] might pursue a dual-class structure that gives them the freedom to focus on long-term strategic projects.[3] As we all know, a founder with a successful business will have more negotiating leverage in implementing a dual-class structure: there’s more evidence that her leadership is important and there’s more demand from investors. But investors may balk at a mechanism that could entrench founders and shield them from accountability, and notable stock indices like the Russell 2000 and S&P 500 have changed their rules to make dual-class shares ineligible for inclusion.

Other Considerations

For a company that has decided to implement a dual-class structure, the first question is when to implement it. Many companies with dual-class stock structures adopt them late in their lifecycle, often immediately prior to their initial public offering, rather than at incorporation.

The second question is when to end the dual-class structure. Often the company’s governance documents provide that the super-voting shares convert into regular shares upon a transfer, or if the founder’s total ownership percentage drops below a specified threshold. The dual-class structure can also include a “sunset” provision that removes super-voting rights after a period of time.

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[1] Snap went public by selling shares of common stock with zero voting rights. The founders and early investors held voting stock.

[2] Other methods of protecting founders include (1) director super-voting rights, allowing an individual director more than one vote; (2) founder protective provisions, giving the founders veto rights over certain key decisions; and (3) large severance packages, forcing the business to pay a pre-set cash amount to a founder on termination.

[3] This concern is often more relevant to public companies, which are dealing with the pressures and incentives of short-term owners and the liquid public markets, and not to private companies.

 

Christopher Poe and Annalise Perry are attorneys at Wyrick Robbins. Their practice focuses on startups, helping businesses of all sizes and in all stages of development, from organization to exit. They assist startups with financings, including angel and venture fundings, and advise them on securities issues. You can email them at cpoe@wyrick.com, or aperry@wyrick.com.  

The purpose of this brief is to provide general information, and it is not intended to provide, and should not be relied upon as, legal advice.